Switzerland's central bank gave up its policy of trying to keep the Swiss franc (SFr) from rising against the euro in mid-January. One result: The bank has had to book a massive loss on its foreign exchange reserves.
Switzerland's central bank, the Schweizerische Nationalbank (SNB), booked a huge net loss for the first quarter of 2015, the bank announced on Thursday in Zurich.
Most of the loss - about 29.3 billion SFr (28.0 billion euros, $31.1 billion) - resulted from a drop in the value of the bank's massive foreign exchange reserves, as measured in SFr. Another 1.0 billion SFr loss was booked as a result of a decline in the value of the bank's gold reserves.
"The national bank's accounting results are predominantly determined by developments in gold, foreign exchange, and capital markets," the bank said in a press release. "Strong swings are therefore the rule, and implications for the bank's end-of-year balances can be drawn only to a limited extent."
Here's the backstory: The Swiss franc is a trusted "safe haven" currency. Whenever there's turmoil in financial markets, the demand for SFr skyrockets.
Financial markets around the world were in turmoil in 2011 - and currency speculators and investors were buying Swiss francs on a massive scale. That drove up SFr's exchange value sharply.
The Swiss watch-making industry is among the export-oriented industries worried by the recent jump in the value of the Swiss franc
That's damaging to Swiss businesses, because an over-valued currency makes imports cheaper and exports dearer. Switzerland is a strong exporting nation - in 2011, goods and services adding up to 65.8 percent of Swiss GDP were exported. A too-strong SFr is a serious problem for the country's economy.
To manage the problem, SNB introduced an exchange-rate peg in September 2011. It committed to ensuring that the value of the SFr would not rise above 1.20 euros.
Infinitely flexible balance sheets
Putting a ceiling on the value of the Swiss franc was easy enough for SNB to do. A central bank can create money simply by entering figures into its electronic spreadsheet - as much as it wants, whenever it wants. There are, however, strict rules in place limiting what it can do with that money, to ensure this power isn't abused.
SNB kept the SFr from rising above 1.20 by creating large quantities of fresh SFr reserves by spreadsheet entry, and using them to buy massive quantities of foreign exchange reserves - i.e. euros, dollars, etc - on global currency markets.
That had the effect of flooding currency exchange markets with SFr, and thereby bringing down the SFr's relative value - thus keeping Swiss companies' products price-competitive in Europe and on global markets.
Over the three and a half years since September 2011, SNB accumulated massive amounts of euros, dollars, and other foreign currencies. At the end of March 2015, SNB was carrying 532 billion SFr worth of foreign exchange reserves on its books.
Stop enforcing the peg
When SNB decided on January 15, 2015 - to the surprise of financial markets - to stop enforcing the SFr currency peg against the euro, and let the SFr float freely on currency markets, the value of the SFr rapidly appreciated.
At time of writing, one euro bought 1.0484 SFr. That meant the SFr had gained 12.6 percent in value by the end of April 2015, compared to its previous level of 1.20 SFr per euro before the currency peg was lifted in mid-January.
The Swiss National Bank's HQ in Zurich. SNB was under pressure from misplaced populist concerns over future inflation risk
SNB reports its accounting results in terms of Swiss francs. The SNB had more than half a trillion SFr worth of dollars and euros on its books when it lifted the peg, and that stock of foreign money declined in value by around 12 percent shortly afterward - as measured in SFr. That accounts for the bookkeeping loss incurred by SNB in the first quarter.
Questions and answers
Q: Does this first-quarter SNB accounting loss have any real-world consequences?
A: Not really. It may or may not cause a change in the amount of profit SNB transfers once a year to its owner, the Swiss government. That remains to be seen. There are three quarters to go before year-end.
Q: If an excessively strong SFr is bad for the Swiss economy, why did SNB lift the exchange-rate peg to the euro?
A: One reason is that the euro weakened considerably against the dollar over 2014. With SFr linked to the euro, that meant the SFr also dropped in relation to the dollar, and to non-euro currencies generally. This made the case for continuing central bank intervention to prevent an over-strong SFr less compelling.
Another reason is that before the peg was lifted, many Swiss citizens feared that SNB's "printing" all those Swiss francs to buy foreign currency reserves would lead to hyperinflation. Driven by those fears, a referendum was held in November 2014 that aimed to restrict SNB's powers to create money by requiring the SNB to hold gold reserves of at least 20 percent of its assets.
While the measure didn't pass - it garnered less than 23 percent voter support - it was very worrying for SNB. Lifting the peg may have been, in part, a measure taken to forestall future efforts to curtail the central bank's powers.
In fact, consumer price inflation in Switzerland has been hovering between zero and slightly negative - i.e. deflation. Citizens' fears of impending inflation were unfounded - based on a misunderstanding of central bank reserve operations and their impacts.
In reality, the central bank reserve money SNB flushed into foreign exchange markets generally didn't circulate in the real economy. It wasn't used to buy goods and services. It merely sat in the accounts of foreign currency investors who wanted to hold Swiss francs as a secure store of value. Money that doesn't circulate in the real economy cannot generate consumer price inflation.
The strong rise in SFr's value in relation to the euro will inevitably have the effect of making Swiss products less price-competitive in the rest of Europe. SNB's decision to lift the peg remains controversial in Switzerland, particularly among people involved in export-oriented businesses.